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Hedging, hedge accounting, and earnings predictability

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  • Tharindra Ranasinghe

    (American University)

  • Konduru Sivaramakrishnan

    (Rice University)

  • Lin Yi

    (University of Houston – Clear Lake)

Abstract

Studies suggest that, pursuant to the implementation of SFAS 133, even sophisticated users of financial statements find it difficult to comprehend earnings implications of hedging derivatives. Moreover, due to stringent hedge accounting requirements under these standards, many economic hedges do not qualify for hedge accounting and are deemed “ineffective” for financial reporting purposes. Motivated by these considerations, we investigate the impact of hedging on earnings predictability by analyzing hand-collected hedging data from two industries that extensively use derivatives to manage price risks: the oil-and-gas exploration and production industry and the airline industry. In contrast to extant evidence, we find that overall hedging derivatives improve income predictability and increase (decrease) analysts’ forecast accuracy (dispersion). We also show hedges deemed ineffective for hedge accounting can increase earnings volatility and significantly impair earnings predictability. This finding lends support to concerns expressed by some corporate managers and industry experts against stringent hedge accounting requirements.

Suggested Citation

  • Tharindra Ranasinghe & Konduru Sivaramakrishnan & Lin Yi, 2022. "Hedging, hedge accounting, and earnings predictability," Review of Accounting Studies, Springer, vol. 27(1), pages 35-75, March.
    • Handle: RePEc:spr:reaccs:v:27:y:2022:i:1:d:10.1007_s11142-021-09595-8
    DOI: 10.1007/s11142-021-09595-8
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    2. Lenka Čiperová, 2024. "The Impact of Hedge Accounting on a Firm Market Value," European Financial and Accounting Journal, Prague University of Economics and Business, vol. 2024(1), pages 21-37.
    3. Ullah, Aziz & Biao, He & Sarwar, Suleman & Wu, Zhongshu, 2025. "Transmission of oil price risk to airline stock returns: Evidence from China and the United States," Research in Transportation Economics, Elsevier, vol. 110(C).

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